When a Giant Gain Causes Pain

Succeeding as an investor takes a strong mind, but a stronger heart. That is especially true when stocks plunge—or soar.
In his letter this week to investors in his hedge funds, manager David Einhorn of Greenlight Capital pointed to “the parabolic rise of a growing number of market-leading story stocks.”

If you have explosive gains on stocks like Fannie Mae (up 968% over the past 12 months), Netflix (up 163% over the same period) or Priceline.com (up 74%), it isn’t just time to reassess what you are investing in. It is time to reassess what kind of investor you are.

For proof, look no further than the remarkable story of Ross Miller and Mary O’Keeffe, a married couple who took a wild ride on a supersonic stock.

Mr. Miller, who died last May at age 59, was a professor of finance at the State University of New York in Albany. Every year, he had his classes analyze and track a stock in the news. But, says Ms. O’Keeffe, Mr. Miller never bought any of them, investing exclusively in diversified index funds—until last February, when that semester’s stock caught his fancy.

It was Tesla Motors, the manufacturer of electric cars, which he bought at around $38 a share.

The stock doubled in the next three months. Then Mr. Miller bought call options on Tesla—bets on a further rise in price that made roughly $30,000 in one week, according to Ms. O’Keeffe.

Early last May, Mr. Miller said to her, “I have something to confess to you.” He had kept the options trade a secret from his wife. “I was so relieved that was what he was confessing,” she says.

Decades earlier, as a young professor at the California Institute of Technology, Mr. Miller had become addicted to options trading, in which even small price movements can produce big gains or losses. “He made some money, then lost it all,” Ms. O’Keeffe recalls. Mr. Miller then made a written commitment never to trade options again, placing the couple’s two favorite stuffed animals next to the pledge and having them “witness” it.
So Mr. Miller felt the need to confess last year because he had violated one of his own rules of self-control. “I gave him absolution,” Ms. O’Keeffe says.

But the options were making Mr. Miller “stressed out,” she recalls. So he sold them and told his wife that if Tesla hit $200 a share, he would consider selling the stock, too.

Ten days later, Mr. Miller died of sudden heart failure.

“Nothing prepared me for the sudden responsibility of managing this,” says his widow. “By training and intellectual preparation I should have been qualified, but I was utterly unprepared for how difficult it would be emotionally.”

Ms. O’Keeffe hadn’t merely been married to a finance professor who pioneered a method for estimating the value that fund managers provide for their investors.

Like her husband, Ms. O’Keeffe earned a Ph.D. in economics at Harvard University. She had taught a course on financial management for nonprofits. She and Mr. Miller ran a consulting firm that advised companies on how to manage financial risks. Ms. O’Keeffe, now 60, is a professor of public finance and tax policy at Union College in Schenectady, N.Y.

But as Tesla “gyrated wildly up and down,” she says, the stock was “too stressful to watch.” She sold most of it at around $140 a share in August. After the stock went up to $194 and down again, she sold the last of her shares at around $130 in November.

Tesla was back above $180 this week, but Ms. O’Keeffe doesn’t care. “I have no regrets,” she says. “I’m so glad not to have to think about it anymore.”

What happened to Mr. Miller and Ms. O’Keeffe isn’t unusual, say experts in the psychology of investing.

If you have a small stake in a company, you own the stock. But if that stake suddenly grows enormous, the stock owns you. Thinking rationally about it then can become all but impossible—even if you have a doctorate in economics.

No matter how closely you analyzed a stock when you bought it, if it has since gone way up, then it is time to start analyzing yourself, says Meir Statman, a professor of behavioral finance at Santa Clara University.

“What many people are afraid of when they have a stock with a big gain,” he says, “is regret.” So you need to figure out which will bother you more: selling the stock and then watching it go up even more, or not selling and then watching it go down.

To manage both kinds of regret on a highflying stock, consider selling, say, 20% in five equal installments at regular intervals. That reduces the risk of selling too soon and of holding too long. As Terrance Odean, a behavioral-finance professor at the University of California, Berkeley, puts it: “Investors should diversify emotionally as well as financially.”